Structured Installment Sales: The Baby Boomer’s Best Friend When Selling Real Estate

Written by Posted On Monday, 21 August 2023 14:19
Structured Installment Sales: The Baby Boomer’s Best Friend When Selling Real Estate Giacomo Lucarini

According to the National Association of REALTORS® Research Group 2022 Home Buyers and Sellers Generational Trends Report, Baby Boomers comprise approximately 42% of all home sellers, more than double the rate of any other group of buyers.

But when it comes to buying, these same statistics also suggest this demographic isn’t necessarily turning around and buying again since only 29% of all home buyers are Baby Boomers.

Put two and two together and about one-third of all Baby Boomers who sell their homes are simply cashing out.

Unfortunately, for those with any significant equity in their homes, that means the most unwelcome of all house guests, capital gains taxes, will be making a lot of noise once the “For Sale” sign goes up leaving the owner in a quandary.

Do they go forward with selling their home and turn over a good chunk of their equity to Uncle Sam? Or will they be better served by simply staying put despite the desire to sell?

Capital Gains Tax Reality Check

In a progressive tax system like we have in the United States, the capital gains tax rate one is required to pay when selling an appreciated asset increases as the size of the gain itself increases. For someone with lower taxable income and a modest gain, taxes can seem almost reasonable. Higher income individuals, however, with more significant equity in the home can see their effective tax rate increase by 50% or more if the gain is significant.    

For instance, a married couple in Anaheim, California, with $75,000 in other income, can expect to pay about 22% of a $250,000 capital gain in federal and state taxes. The effective tax rate for that same couple jumps to about 35% on a gain of $3,000,000.

Since many Baby Boomers have owned their homes for decades and possess significant equity, they will be eager to learn about any strategies designed to help them keep as much of their sales proceeds as possible. As the old adage goes, “everyone must pay taxes, but there’s no law that says you’ve got to leave a tip.”

Enter Installment Sales

Fortunately, one method of straightforward capital gains tax deferral is already built into the Internal Revue Code codified in 26 U. S. Code Section 453 – Installment method.

At its core, 453 permits the selling of a qualifying asset on the installment method where at least one payment is made “after the close of the taxable year in which the disposition occurs.” When so doing, taxes are due only in the taxable year the funds are received versus all at once in the year of sale.

The net effect of this arrangement is the seller paying lower total taxes over multiple years versus the higher taxes they’d owe if all the proceeds are received in a lump sum at closing.

Historically, buyers and sellers would arrange for the installment sale between themselves. Instead of paying the entire sales price up front when the property is purchased, the buyer and seller agree that the buyer will pay a portion of the sales price at closing, and then promise to pay the rest of the money due over a time. The parties will have negotiated an interest rate the buyer will pay for this seller financing arrangement and the terms are contractually memorialized in the sales agreement and closing documents.

If everything works out as planned, everybody is happy. The seller receives tax deferred income which results in a lower overall capital gains tax obligation, and the buyer gets some “float” to buy the property.

But for every traditional installment sale that works out well, there are countless examples of these deals falling apart. What if the buyer loses their job and is unable to make the agreed payments? Or dies? Or simply walks away from the property during a market downturn? The original seller now must take the property back and all the tax consequences that come with it.

A BETTER Installment Sale

But what if you could combine the benefits of selling on the installment method with the added security of the future income being guaranteed by a highly rated financial institution or U.S Treasuries? Turns out you can by utilizing a strategy that continues to grow in popularity, a STRUCTURED Installment Sale.

Here’s how it works:

  1. Buyer and seller agree to a sales price for the property, the full value of which the buyer must provide at closing. Whether it’s an all-cash deal or the buyer secures a traditional mortgage, the same process will be followed.
  2. An addendum to the purchase agreement will specify that a portion of the agreed sales price will be used to fund a series of future guaranteed periodic payments which the seller will have previously selected in consultation with a duly licensed structured installment sales expert. These future payments will include not only the deferred funds themselves, but some tax-deferred interest earned.
  3. In addition to the addendum, buyer and seller will also execute some required paperwork which gives full force to the agreement. Both must acknowledge that this transaction is fully compliant with Section 453 of the Internal Revenue Code.
  4. At closing, the funds the seller elected to defer are sent directly to the company agreeing to make the future payments.
  5. Capital gains taxes, along with any deferred interest earned through the structured installment sale process, will be paid in future years at rates then in effect.

By eliminating the risk of buyer default, security and peace of mind is achieved because the seller now looks to the financial viability of the entity guaranteeing the future installment payments. In order to comply with the tax code and all the relevant Revenue Rulings, it’s crucial to make sure the proper steps are followed.

In Conclusion

Baby Boomers have a variety of good reasons for selling their homes. Many are doing so to move closer to their families, friends and/or relatives. Some are doing so because of retirement or simply because it’s time to downsize. Whatever the reason, when high capital gains taxes look like they could otherwise cloud the decision-making process, a structured installment sale is a money-saving option worth considering.

(NOTE: This content is provided for educational purposes only. Tax, legal, and/or accounting advice is neither intended nor implied.)

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Dan Finn

Dan Finn, the owner of Finn Financial Group, LLC in Newport Beach, CA, placed his first structured installment sale in 2006 and has been a leading advocate for this unique tax deferral strategy since then. Licensed throughout the United States, Dan is available to consult on transactions across the country at no cost to the buyer or seller.

Dan can be reached at (949) 999-3322.

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